Have Market Views on the Sustainability of Fiscal Burdens Influenced Monetary Authorities' Credibility?

40 Pages Posted: 31 Oct 2011

See all articles by Gabriele Galati

Gabriele Galati

De Nederlandsche Bank

John Lewis

De Nederlandsche Bank - Econometric Research and Special Studies

Steven Poelhekke

VU University Amsterdam; De Nederlandsche Bank

Chen Zhou

De Nederlandsche Bank; Erasmus University Rotterdam (EUR) - Erasmus School of Economics (ESE)

Date Written: July 1, 2011

Abstract

During the Great Crisis, most governments in industrial countries supported their domestic financial sector under stress and responded to strong declines in output growth with fiscal stimulus packages. Starting in 2010, attention focused on the sustainability of the resulting debt burdens. We conduct an empirical study to test whether in the United States, the euro area and the United Kingdom, views on the sustainability of fiscal burdens have influenced markets’ assessment of central banks’ commitment to price stability. Using a daily measure of inflation expectations extracted from nominal and indexed-linked government bonds, or inflation swaps, we test whether these react to alternative measures of fiscal burdens. These include rescue package announcements, credit default swap (CDS) spreads and changes in either the outlook or the credit rating of governments. We find no evidence of a significant effect of market participants’ perceptions of fiscal burdens on long-term inflation expectations in the United States, the euro area and the United Kingdom. These results are broadly consistent with the view that long term inflation expectations have remained well anchored.

Keywords: fiscal policy, monetary policy, inflation and inflation compensation, anchors for expectations, crisis

JEL Classification: E31, E44, E52, H63, H68

Suggested Citation

Galati, Gabriele and Lewis, John and Poelhekke, Steven and Zhou, Chen, Have Market Views on the Sustainability of Fiscal Burdens Influenced Monetary Authorities' Credibility? (July 1, 2011). De Nederlandsche Bank Working Paper No. 304. Available at SSRN: https://ssrn.com/abstract=1951894 or http://dx.doi.org/10.2139/ssrn.1951894

Gabriele Galati (Contact Author)

De Nederlandsche Bank ( email )

PO Box 98
1000 AB Amsterdam
Amsterdam, 1000 AB
Netherlands

John Lewis

De Nederlandsche Bank - Econometric Research and Special Studies ( email )

Amsterdam
Netherlands

Steven Poelhekke

VU University Amsterdam ( email )

De Boelelaan 1105
Amsterdam, ND North Holland 1081 HV
Netherlands

HOME PAGE: http://https://sites.google.com/site/stevenpoelhekke/

De Nederlandsche Bank ( email )

PO Box 98
1000 AB Amsterdam
Amsterdam, 1000 AB
Netherlands

Chen Zhou

De Nederlandsche Bank ( email )

PO Box 98
1000 AB Amsterdam
Amsterdam, 1000 AB
Netherlands

Erasmus University Rotterdam (EUR) - Erasmus School of Economics (ESE) ( email )

P.O. Box 1738
3000 DR Rotterdam, NL 3062 PA
Netherlands

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